July 25, 2024

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What Is an Unrecaptured Section 1250 Gain?

Unrecaptured section 1250 gain is an Internal Revenue Service (IRS) tax provision where previously recognized depreciation is recaptured into income when a gain is realized on the sale of depreciable real estate property.

Unrecaptured section 1250 gains are taxed at a maximum 25% tax rate, or less in some cases. Unrecaptured section 1250 gains are calculated on a worksheet within the instructions for Schedule D, reported on Schedule D, and carried through to the taxpayer’s 1040.

Key Takeaways

  • An unrecaptured section 1250 gain is an income tax provision designed to recapture the portion of a gain related to previously used depreciation allowances.
  • It is only applicable to the sale of depreciable real estate.
  • Unrecaptured section 1250 gains are usually taxed at a 25% maximum rate.
  • Section 1250 gains can be offset by 1231 capital losses.
  • Section 1250 applies to real property, whereas Section 1245 applies to personal property.

How Unrecaptured Section 1250 Gains Work

Section 1231 assets include all depreciable capital assets held by a taxpayer for longer than one year. Section 1231 is the umbrella for assets belonging to section 1245 and section 1250, and the latter is what determines the tax rate of depreciation recapture.

Section 1250 relates only to real property, such as buildings and land. Personal property, such as machinery and equipment, is subject to depreciation recapture as ordinary income under section 1245.

Unrecaptured section 1250 gains are only realized when there is a net Section 1231 gain. In essence, capital losses on all depreciable assets offset unrecaptured section 1250 gains on real estate. Therefore, a net capital loss overall reduces the unrecaptured section 1250 gain to zero.

A section 1250 gain is recaptured upon the sale of depreciated real estate, just as with any other asset; the only difference is the rate at which it is taxed. The justification for the gain is to offset the benefit of previously used depreciation allowances. While the gains attributed to accumulated depreciation are taxed at the section 1250 recapture tax rate, any remaining gains are only subject to the long-term capital gains rate of 15%.

Example of Unrecaptured Section 1250 Gains

If a property was initially purchased for $150,000, and the owner claims depreciation of $30,000, the adjusted cost basis for the property is considered to be $120,000. If the property is subsequently sold for $185,000, the owner has recognized an overall gain of $65,000 over the adjusted cost basis.

Since the property has sold for more than the basis that had been adjusted for depreciation, the unrecaptured section 1250 gains are based on the difference between the adjusted cost basis and the original purchase price.

This makes the first $30,000 of the profit subject to the unrecaptured section 1250 gain, while the remaining $35,000 is taxed at the regular long-term capital gains rate. With that result, $30,000 would be subject to the higher capital gains tax rate of up to 25%. The remaining $35,000 would be taxed at the long-term capital gains rate of 15%.

Special Considerations

Since the unrecaptured section 1250 gains are considered a form of capital gains, they can be offset by capital losses. To do so, the capital losses must be reported through Form 8949 and Schedule D, and the value of the loss may vary depending on whether it is determined to be short-term or long-term in nature.

For a capital loss to offset a capital gain, both must be determined to be short-term or long-term. A short-term loss cannot offset a long-term gain and vice versa.

What Are Examples of 1250 Property?

Examples of section 1250 property include commercial buildings or residential rental property. Commercial buildings would be treated as MACRS 39-year real property, while the residential rental property would be treated as 27.5-year property.

How Can You Avoid Paying Back Depreciation Recapture?

Investors can avoid paying tax on depreciation recapture by turning a residential property into a primary residence. In addition, the taxpayer could conduct a 1031 tax-deferred exchange. Also, when an investor passes away, their heirs often receive the property on a stepped-up basis.

How Much Tax Do I Pay on Unrecaptured Section 1250 Gain?

The maximum rate attributable to unrecaptured section 1250 gains is 25%.

How Do I Calculate Section 1250 Recapture?

Section 1250 is calculated as the lesser of two amounts. The first amount is the excess of accelerated depreciation claimed on real property over what would have been the allowable amount under a straight-line method. The second amount is the gain realized upon disposition.

What Triggers Depreciation Recapture?

Depreciation recapture occurs when there is a difference between the sale price of an asset and the tax basis or adjusted cost basis. The difference in these two amounts is recaptured by reporting the difference as ordinary income.

The Bottom Line

Section 1250 gain is a tax term that refers to the taxable gain from the sale of depreciable real property. The term comes from Section 1250 of the Internal Revenue Code (IRC), which deals with the tax treatment of depreciation recapture.

When a property owner sells a depreciable asset, the IRS requires the owner to recapture a portion of the depreciation claimed on the property over the years. The recaptured amount is taxed at a special rate known as the Section 1250 recapture rate, which is generally 25%.

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